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ECN 132 Summer Session II – Practice Problems

1. Do socioeconomic differences in health exist only in countries like the United States where there is no universal health care, or also in those countries where there is universal healthcare? Briefly explain.

Socioeconomic disparities in health exist in all countries. For instance, in the study we discussed regarding civil servants in Britain, there were disparities in health outcomes even though everyone has access to care. Moreover, queue length in the UK suggests less-educated and poorer individuals wait longer. The well-educated wait 9% to 14% less than less-educated patients.

2. Suppose Drug B costs $30,000 to produce and the extended life expectancy from taking Drug B is 1.5 years. If the extended life expectancy from taking Drug A is 3 years and the ICER (incremental cost-effectiveness ratio) of using Drug A over Drug B is $5,000 per year of extended life expectancy, how much does Drug A cost to produce?

In order to calculate the ICER, we take the difference in cost and divide it by the difference in effectiveness. The difference in the cost divided by the difference in effectiveness (1.5) needs to equal $5,000. Therefore, the difference in costs is $7,500, and since Drug B costs $30,000, Drug A costs $37,500 to produce.

3. What are the three factors that are necessary for moral hazard to exist?

Price distortion – The individual does not pay the full cost of the health bill.

Price sensitivity – The individual changes his/her behavior because of the change in price. The demand curve is not perfectly inelastic.

Asymmetric information – Insurance companies would be able to ‘price’ the extra risk the customer takes if there was not asymmetric information

4. How did the increase in premiums for Harvard employees (the study we discussed in class) provide evidence for adverse selection in health insurance? Briefly explain.

There were two different health insurance programs. The more comprehensive insurance became more expensive and, as a result, began including fewer and fewer individuals (unhealthy ones) leading to higher and higher premiums.

The PPO (more expensive plan) cost $361 more in 1994, but cost $731 more in 1995. PPO enrollment declined from 18% to 14% in 1995. The stayers were older on average. The fact that the insured were increasingly unhealthy caused the insurance company to raise premiums.

5. Why was the RAND health insurance experiment unique and why are its results still used today? Briefly explain.

The RAND health insurance experiment was unique because it was able to randomly expose different individuals to different prices of care because families were randomly allocated to different insurance programs in terms of their comprehensiveness.

Therefore, the price of care was not correlated with the probability of someone needing care, which enabled researchers to get a sense of the ‘true’ demand curve for different types of care. Because of the attention to detail and random design of the experiment, the results are still used today.

6. Suppose Chuck pays a premium of $200 and his payout if he gets sick is $1,000. If you know that his insurance is partial and unfair, what are possible values for IH (income if healthy), IS (income if sick), p (probability of being in the sick state). Briefly explain.

IH = _______        IS = _______        p = ________

If Chuck’s insurance is partial and unfair, this means that the premium he is paying is less than the probability of getting sick times the payout. The insurance contract would be fair if the probability of getting sick is 0.2 (because 0.2*$1000 = $200). Because the premium is unfair, the probability of getting sick is less than 0.2.

Because the contract is not full, this means that the payout is less than the difference in incomes in the sick state and the healthy state. Suppose the income in the healthy state is $2000, then the income in the sick state has to be less than $1000 (for instance, $900).

7. What are the three main parts of the Affordable Care Act (Obamacare). Briefly explain each.

The three main components of the ACA are:

1. Medicaid expansion – States were required to cover a broader range of individuals. The problem was that states could opt out of this additional adoption. Medicaid expansion was supposed to expand Medicaid to another 17 million individuals.

2. An individual insurance mandate – All individuals who did not have insurance through their employer or Medicaid/Medicare were required to obtain it from their state-wide market created by the ACA

3. Cuts to Medicare spending – In order to provide millions of people with healthcare, and the expenses that come along with it, Medicare needed to be downsized (to a degree).

8. What are two similarities between the Beveridge type healthcare system and the American healthcare system? Briefly explain.

One similarity between the two systems is the use of gatekeepers. An individual who needs care first has to see their general physician before they can see a specialist.

An additional similarity is the provision of care for free (or highly subsidized rates). In Beveridge countries this is provided for everyone and in the US the two forms of public insurance are Medicaid and Medicare.

9. What are two ways in which the Medicare system attempts to control costs?

1. Cost-sharing – Just like other insurance programs, Medicare does not make the cost of care $0. This is in place so that individuals only have an incentive to seek care when they really need it.

2. A more significant cost control mechanism than cost-sharing is the Diagnosis Related Group (DRG) system (introduced in 1984). Under this system, Medicare pays a fixed amount to hospitals based upon the diagnosis the patient has when admitted to the hospital, rather than on his length of stay or the extent of care given.

10. Overall, do areas in the US that spend more on healthcare have better health outcomes as well? If not, briefly explain why not.

No, in general there is no correlation in the US between spending and outcomes. It seems like much of the disparity in expenditures is the result of supply-sensitive care. This is the idea that if more expensive technology if available, it is more likely to be used, even if it only offers a slight improvement in health outcomes.

One of the ways to look at differences in spending is through the health production frontier (HPF). If communities are not on their HPF they are getting less for their spending than communities who are on their HPF.

Moreover, communities may have different HPFs. Even if operating efficiently, a dollar in one community will go farther than a dollar in another community if they have different HPFs.